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Actuaries Scrutinized on Pensions

By firing its actuarial consultant last week, the New York State Legislature shone a light on one of the public sector’s deepest secrets: All across the country, states and local governments are promising benefits to public workers on the basis of numbers that make little economic sense.

The numbers are off-base for a variety of reasons. Sometimes there is a glaring conflict of interest, as there was in Albany, where the consultant was being paid by the workers seeking richer benefits. More often, there is subtle pressure on the actuary to come up with projections that make the pension fund look good.

Most of all, public pension actuaries use old methods that have fallen far out of sync with the economic mainstream. That does not necessarily mean their figures are wrong, but it does make them vulnerable to distortion, misunderstanding and abuse.

“Financial burdens have been hidden” as a result, said Jeremy Gold, a New York actuary and economist who was one of the first to call attention to the gap between actuarial figures and economic reality. Many economists now agree with Mr. Gold, saying they believe actuaries are routinely underestimating the cost of providing governmental pensions by as much as a third.

In the private sector, pension funds are highly regulated, and actuarial numbers are less of an issue. But in government, actuaries and the consulting firms that employ them are starting to draw lawsuits in places like Alaska, San Diego, Milwaukee County, Wis., and Evanston, Ill.

In Texas, the attorney general is calling for actuaries to be registered, so the state can keep them on a shorter leash. Federal regulators are also flexing their muscles, and the actuarial rules-making board is being pushed to change.

Two big problems are being laid on actuarial doorsteps: overly aggressive investing and overly rich benefits. Benefits can go off the scale because widely used actuarial methods tend to make them look inexpensive. And this tends to encourage aggressive investing, because the greater the risk in the portfolio, the less costly it can seem to provide the benefits.

“Actuarial assumptions based on misinformation are a recipe for disaster,” said the Texas attorney general, Greg Abbott.

After the Fort Worth pension fund was found to have a crushing $410 million deficit, Mr. Abbott sent his staff to dig through more than a decade’s worth of documents, to find out why. They found that in 1990, an actuary had calculated that the city could put less money into the pension fund and increase workers’ benefits simultaneously — without making a dent in the fund — if he assumed that the fund would earn 10.23 percent a year on its investments.

This worked on paper but not in the real world. In reality, Fort Worth actually lost money on its pension investments that year. And the new benefits did, in fact, have a cost. But the city forged ahead, armed with an actuarial opinion letter stating that “the numbers are correct.” It generously sweetened public workers’ benefits five times in subsequent years.

From time to time, the actuary issued muted warnings, but he was ignored. He also began tweaking other numbers in his calculations, which kept the plan looking viable on paper. Meanwhile, the imbalances in the pension fund compounded.

“It went bust,” said David C. Mattax, the attorney general’s chief of financial litigation.

Fort Worth is now trying to come up with a reform package to bring the city pension fund back into balance. It is struggling, though, because its proposals are expensive, and some have been found unconstitutional.

Something similar happened in New Jersey. In 1994, the state needed money, and it made actuarial changes that allowed it to avoid putting billions of dollars into its pension fund. The state then spent the money on other things.

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Greg Abbott, attorney general of Texas, has said that actuarial assumptions based on misinformation are a recipe for disaster.Credit
Harry Cabluck/Associated Press

Members of the pension oversight board resigned in protest, and employee groups sued, but an actuary for the state provided a detailed opinion letter saying the new method “will securely fund the present benefits” and even produce a modest surplus.

Two years later, a state senate committee called back the actuary, Robert D. Baus, for questioning, to make sure all was well. Senator Peter A. Inverso noted that a $4 billion deficit had appeared in the pension fund. “That frightens me,” he said. But Mr. Baus said that while the deficit had grown, “it does not change the fact that the system is funded.” He said New Jersey would have to close the shortfall at some point, but in the meantime, “it does not mean that there is not enough money to cover the liabilities right now. There is more than enough.”

No one asked exactly when the shortfall would have to be closed. Instead, legislators kept withholding pension contributions, even as they increased benefits again and again. Over the years the imbalances in the fund finally snowballed.

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Now the fund is so deep in the red that Governor Jon S. Corzine’s administration cannot find the cash to catch back up. The Securities and Exchange Commission is investigating.

Alaska is also struggling with a sick pension fund, and complaining its actuary got it into trouble. In Alaska, the state pension fund pays for retirees’ health care as well as pension benefits. The actuarial firm that crunched the numbers for the plan, Mercer, made the assumption that health care inflation would fall to 4.5 percent by 2009. Instead, health care costs have gone up.

The difference looks small in percentage terms, but multiplied over many years, and 80,000 workers and retirees, it is enormous. Alaska has sued Mercer for $1.8 billion, arguing that it “failed to take into account real-world data,” and, therefore, allowed the state to make unreasonably low contributions.

Mercer has said that it did nothing wrong, and that Alaska is trying to blame it for investment losses and other factors beyond its control.

Mercer is also being sued by Milwaukee County, where the pension fund has been draining the budget for years. The county accuses Mercer of underestimating the cost of new benefits that were promised in 2001. Mercer says the county caused the problems itself, through its mismanagement.

In Evanston, Ill., a former actuary has been accused of using aggressive assumptions about such things as investment returns, after a new actuary discovered a big shortfall. The former actuary has said his assumptions were valid and the plan had weakened because it was highly leveraged.

San Diego’s official numbers produced by an outside actuarial firm were found to be so misleading that the S.E.C. sanctioned the city for securities fraud. The city sued the actuarial firm, which settled.

The New York State Legislature has dropped several proposed pension enhancements since lawmakers learned that the actuary, whose opinion was that the cost of the benefits would be zero, was being paid by a labor group. The actuary said his assumptions were within acceptable ranges. But the state’s actuarial methods continue to be contentious, showing the pension fund is fully funded even when markets turn down.

Actuaries worry their profession cannot withstand too many large lawsuits. The board that writes actuarial standards has been working on revisions in how to make economic assumptions.

But change is coming at a creep. There are still a large number of actuaries for public plans who vigorously defend current methods.

In Washington, the Internal Revenue Service is seeking to intervene. It is an active regulator of corporate pension funds, but has seldom been involved with public plans until recently. At a recent informational event, I.R.S. officials explained that they wanted to help, and would send out an anonymous questionnaire.

“The law in this area is complex, and mistakes do happen,” said Joyce Kahn of the I.R.S.’s Employee Plans Voluntary Compliance division. “They happen all the time.” She said errors cost much less if they are corrected right at the beginning.

Many public fund officials, however, have resisted cooperating with the I.R.S., citing states’ rights doctrine.